Consumer Discretionary Sector 101

This month at The Motley Fool, we're taking an all-hands-on-deck approach to getting back to basics, culminating on September 25 with Worldwide Invest Better Day. With this in mind, my Foolish colleagues and I are opening the floodgates with vital information to help you invest better. In a previous article, we reviewed stock diversification, a key fundamental of investing. We're taking a look at market sectors one by one, focusing today on Consumer Discretionary.

The ins and outs of the sectorThe Discretionary sector begs notice since consumer spending represents over two-thirds of U.S. GDP. Discretionary products constitute big-ticket items like cars, jewelry, travel, and other goods that we purchase infrequently. We're more apt to buy these when we feel richer, typically during robust economic times. Using the MSCI World Sector Weightings as a benchmark, roughly 10% of your overall stock portfolio should be allocated to Consumer Discretionary.

How the sector performsDiscretionary stocks enjoy more upside during a vigorous economy when investors place a premium on these companies. That being said, Discretionary stocks typically outperform the overall stock market when the economy is purring along. For example, from March 2009 to present, the Discretionary sector returned 208% versus 128% for the market. Typically, during a weak economy, the sector underperforms, and, over long spans of time, the sector usually outperforms. During the past decade, Discretionary stocks returned 111% versus 96% for the S&P 500.

Challenges and trends facing the sectorAffluent consumers spend heavily on luxury goods and services, which are viewed as status symbols. The top 20% of households account for up to 60% of consumer spending. Offering apparel like clothing, handbags, and accessories, luxury retailer Michael Kors (NAS: KORS) , balances offering both pricey and more affordable apparel without brand degradation. Most of all, companies who sell to the affluent sell an ideal, or a lifestyle. A continually strong performer in the high-end retailing space, lululemon athletica (NAS: LULU) sells $100 yoga pants, but their consumers connect with the brand because they yearn for a more zen-like lifestyle.

Brand power significantly distinguishes one Consumer Discretionary company from another. Even though Ford (NYS: F) flirted with bankruptcy and was tempted by, but refused, TARP dollars, the company's strong brand and experience navigating 100-plus years of potholes and headwinds helped it remain in the drivers seat among U.S. auto manufacturers. While the financial crisis left Ford spinning its wheels, since then the stock is up handily.

As disposable incomes increase, more luxury goods and services are purchased in geographies unthought-of in the past. In developing nations, middle-class consumer spending is expected to grow to $20 trillion annually by 2020, up from $7 trillion in 2010. To capitalize on this, Wynn Resorts (NAS: WYNN) doubled down, starting in 2006, with vigorous expansion into high-growth market Macau, a special administrative region of China. The region boasted a 42% increase in gaming revenue last year.

Of course, the elephant in the retailer's room is e-commerce. Today roughly 5% of total retail sales are online; this is expected to skyrocket. Amazon.com (NAS: AMZN) continues to threaten big box Consumer Discretionary retailers like Costco and Best Buy. With the prolific adoption of tablets and smartphones, this trend will put further pressure on megaretailers.

An easy way to own the sectorIf you're clueless when it comes to Consumer Discretionary stocks, consider exchange-traded funds (ETFs). ETFs mimic the performance of an index, like the S&P 500, or provide specific exposure to certain sectors. Sector specific ETFs like Consumer Discretionary Select Sector SPDR ETF are helpful when you lack information to hypothesize an investing thesis.

You: A better stock investorIf you bet wrong in the stock market, it could cost you dearly. Instead, develop a diversified strategy for adding all sectors to your portfolio. That way, regardless of what happens in the market, you'll know a portion of your portfolio will prevail.

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